Hello September. You always make things interesting for investors. In seasonal fashion, the Market trend reversed sharply since Labor Day. It was a rather tumultuous week for investors. September is historically the worst month for stocks. The rally from the corrective lows earlier in the year has stalled a bit, after hitting the fresh new highs to close out August. Attention has shifted back from fundamentals to politics and geopolitics, which almost always invite volatility. Market jitters are the norm.
The Fundamentals remain quite strong under the hood of this Market. 201,000 jobs were created in August. That was ahead of expectations. What was most compelling was the wage increase of 2.9%; much higher than expected. It was the largest increase in a decade. One important takeaway is this strong job number is another piece of evidence of the underlying strength of the US economy. The other takeaway is the Fed is going to maintain its interest rate hike campaign, with one later this month and another now very likely in December. The Market is assigning a virtual guarantee that the Fed raises by ¼ point in 3 weeks, and the probabilities jumped to 79% for a December hike. It was 70% a week ago. The Market seemed to have liked the idea that the December hike would be pushed out to next year. That’s why stocks sold off after the print this morning.
Interest rates are jumping, with the 10-Year Treasury yield is pushing 3% again. The Dollar has been strong too, also putting a dent in stocks and commodities. Bonds sold off too. Talks on trade seem to be dying again which the Market doesn’t like. There is no deal with Canada yet. More tariffs on China are on the docket and apparently Japan is the next target. The outperformance of the S&P versus international markets is making it obvious who is winning this war, even though nobody really wins. We are back to a tug-of-war Market. It’s pretty normal these days.
Many are wondering: Is this as good as it gets? Earnings are growing 25% this year. The unemployment rate is 3.9%, the lowest since the 1960s. What’s new is the wage growth. The lack of wage gains has been a critical missing ingredient in this Bull cycle. Most Americans have not been getting raises. This is a positive sign for purchasing power. The US economy is 70% consumer spending. This is no small deal. But that will lead to some more Fed brake-tapping. Rising rates will put a crimp in purchasing power. You can see the tradeoff.
The fact remains, American wages are still low. 80% of US workers live paycheck to paycheck. Many have not fully recovered from the Financial Crisis from 10 years ago. Only 55% of Americans are invested in the stock market today. 62% were invested in 2000 and 65% in 2007. Only 38% of American workers participate in 401k plans. One issue is, not every company offers an employee retirement plan. But even those that do, still see a high percentage of employees that don’t participate. The power of saving and compounded interest are undeniable, but they still aren’t widely understood. Financial education is critical and still lacking. Americans just aren’t properly prepared for their financial lives early enough.
We keep studying the fund flows as a contrarian sign. Over $7 Billion moved out of equity funds this week. This was the greatest outflow since the end of June. Consequently, that occurred right before stocks surged in July and August. Money tends to chase performance, leading to buying high and selling low. That runs completely counter to logic and intent. Emotion definitely plays a role. We keep seeing strength rotating from sector to sector. The “Generals” or leading large cap stocks have sure done their part and led this last leg higher, and now it’s time for cyclicals and higher “beta” or risk stocks to start to deliver to the upside. Tech is showing signs of slowing and it is unrealistic to expect it to continue to charge higher at the same pace. Rotation is the next ingredient for the next leg higher from here. This could start with Emerging markets, Financials, Health Care and Industrials. When fund flows reverse back into stocks in size, it will catch our attention and signal the end of the rally is nearing. We still see higher levels to be had in 2018.
We expect the news flow to continue all weekend about politics, geopolitics and trade. We are ready for whatever comes our way. We’ve got you covered.
Have a nice weekend. We’ll be back, dark and early on Monday.